Mortgages

All about home mortgages

Mortgages represent a lender's security for the debt a homeowner assumes when he or she gets financed for the purchase of a piece of property. In the United States, home mortgages are the standard means by which a person gains ownership of a house, and virtually every real estate buyer will need a mortgage loan to acquire a piece of property.

How Home Mortgages Work

When you buy a house, you'll have to make a down payment. The amount of your down payment is subtracted from the total price you're paying for your new home. The remainder is financed by the financial institution underwriting your mortgage.

In the United States, there are two different legal frameworks used to define who owns the house while you're paying the mortgage off. Some states use what's called the "title theory," in which the lending institution is the holder of the title deed to your property. If you can't make your mortgage payments, the lender will then sell your house to a buyer to recoup the money you're unable to pay them.

The second framework is called the "lien theory." In states that use liens, you actually hold the title to your house, but your financial institution can put a legal claim on the title if you default on your payments. This claim is called a "lien." If you default on your payment obligations, the lender can foreclose on the lien and sell your property to another buyer to recover their money.

In both cases, home loans are paid down over a specified number of years. This process is called amortization. When you've paid off the entire outstanding balance, you own the house free and clear.

Most lenders offer you some degree of choice when it comes to your amortization period. To determine the best option for you, use a mortgage calculator; these are widely available online. You simply enter the amount of your down payment, then enter the mortgage rates you were offered and the number of years you want to take to pay the mortgage off. The calculator will return a monthly payment amount. If you can afford to pay more, select a shorter amortization period. If you need lower monthly payments, select a longer amortization period.

Types of Mortgages

There are two basic types of mortgages: a fixed rate mortgage and a variable rate mortgage. The difference is very important: a fixed rate mortgage locks you into a single interest rate for the life of the amortization period, regardless of any fluctuations in the prime interest rate. This can be advantageous because your mortgage interest rate will stay the same even if the prime rate rises. However, fixed rate mortgages tend to be significantly higher than the prime rate when the mortgage is created.

Variable rate mortgages are usually tied to the prime rate or to your financial institution's set in-house rate. For example, the interest on your variable rate mortgage might be calculated at prime plus 1.75 percent, or prime plus 2.25 percent. The advantage of a variable rate mortgage is that the initial rate is usually lower, and you'll save a lot of money if interest rates dip. However, if interest rates rise, your amortization period will be extended if you want your monthly payments to remain the same. Variable rate mortgages can be advantageous in the short term but are fraught with risk over the long haul.